I decided to dig deeper into the question of the SPY/QQQ price outperformance compared to previous years. This outperformance carries all the signs of a bubble, which is most apparent in the QQQ 2017 outperformance.

What about the Money Flow seasonality?

I have compiled a database of Large Effective Volume and price data for more than 1000 stocks. The multiplication of both values offer a view of the waves of money originating from large investors. I call it the Money Flow, because the Large Effective Volume is by definition a volume and multiplying it by the price of each component of an index offers a vision of the evolution of the Money Flow. However, this Money Flow still only represents the result of an equilibrium between large buyers/sellers.

As we can see below there has been a clear August Money Flow weakness for the S&P500. I would say that Large investors might be at the beach, leaving markets to algos monitored by younger assistants. Hence, there is less money moving in, but prices were unchanged.

It is interesting to note here that in 2017 the S&P500 is greatly outperforming the average price gains of previous years. However, in terms of Money Flow we are just in-line with past years money flow. What does this tell us? This tells us that either sellers are not very active (Buy and keep such as Index investors or the Swiss Central Bank do) or that money is more and more concentrating in a few stocks. More below about this.

Small caps also show the same type of August weakness, which corroborates the weakness in prices. If you are short the small caps, MF seasonality tells you to cover by September.

It is interesting to note that Pink and Blue lines in the price gain Figure below correlate almost perfectly with the Blue/Pink lines of the Money Flow Figure. We might also note (Red Arrows) the negative divergence of the past weeks, which tends to indicate that the recent small caps price gains are not supported by the Money Flow.

The NQ100 Money Flow even looks more interesting. We can see that

1. For 2017 the Money Flow calculated on each component of the NQ100 is clearly outperforming past QE years averages
2. There is no seasonality linked to the NQ100 Money Flow

However, if we separate the 8 most popular NQ100 stocks from the 92 others, we can see that these 8 stocks have been attracting about 85% of all the money of the Index. These stocks are MSFT, AAPL, FB, NFLX, AMZN, GOOG/GOOGL, TSLA and NVDA.

When we look at the MF on the 92 remaining stocks, we can see a clear August weakness back in the Figure. Most importantly, we can notice that the MF in 2017 for these 92 small NQ100 stocks is basically in line with past averages. This points to a bubble that is concentrated in only a few stocks.

Of course, we have all known this for a while. This is the reason why I have used my Mammoth Index. However, this Mammoth Index also includes stocks such as T, GE, CELG and BAC, which seem to carry less hype.

I ran a similar MF analysis on the Mammoth sector. We can see below that the results and the outperformance of the Mammoth sector in 2017 is almost identical to the Money Flow pattern of the eight most active NQ100 stocks.

I therefore decided to calculate the MF only on the four stock that seem to carry less hype: CELG/T/GE/BAC. We can see below that the MF on these four very big stocks is almost irrelevant.

As a reminder, the Money Flow calculated as the LEV X Price for each component is not a measure of a strength but of an equilibrium. What the Figure below tells us is that these four stocks are irrelevant in terms of finding out anything about the current market They have been traded up/down in a rather equilibrated manner, albeit somewhat negative (more sellers than buyers)

Conclusions

1. The first immediate conclusion for me is that I need to change the current Mammoth Sector and instead use the 8 most popular stocks of the NQ100 because these are the ones with the most influence on the market: they are both price and liquidity leaders. This Figure will be updated here every day:

2. Except for these eight stocks, all the rest of the market showed a seasonal negative MF around August. This occurred after the eight stocks have issued their earnings. On paper, it looks like a rotation from everything else into the price/liquidity leaders.

3. Because of the IWM Price/MF divergence in July 2017 and the negative seasonality of August, it makes sense to short the small caps all through the end of August.

Some hypotheses for the next weeks

1. Foreign central banks such as the SB, which openly buy US equities, are acting for their own interest. They are not buying to support the general market. Hence, I believe that they will sell if they see it wise.

2. The Fed is not investing in US equities. Yellen has stated several times that equities are priced too high, but she is confident that she can always keep equities prices in check through reverse repo and the management of Excess Reserves. However, because Yellen needs to unwind QE starting in September, she had to make a dovish statement regarding interest rates. She was therefore responsible for the latest spike in equities prices. This is something that she doe snot welcome.

3. Index investors however have been selling the QQQ since May.

4. Large investors are also seeking protection

Compared to past Years, 2017 looks really negative in terms of LEV. This probably means that besides index investors selling, we also have traditional funds seeking protection through opening shorts in the QQQ ETF, while buying the eight most popular stocks. Moreover, if we follow the seasonal pattern of past years, selling should continue through August.

5. The effects of the ETFs positive contagion

One feature of this market is that the 8 most popular stocks have forced ETFs managers to buy all the rest of the 92 NQ100 and the S&P500 stocks simply because they need to adjust the ETF to the price gains of the most popular stocks. This positive contagion effect of the QQQ ETF on the smaller components is however limited by the fact that the QQQ has a total capitalisation of 50B$, which is only 1.6% of the total capitalisation of its Five biggest components.

6. A negative contagion to the small caps

It is interesting to compare the three ETFs price gains in 2017: QQQ/SPY/IWM. If we suppose that the leading stocks are the Eight most popular stocks of the NQ100, we can detect (Green arrows) four buying moves, which all of them influenced SPY and IWM.

However, small caps pullbacks have been deeper than for the rest of the market. This probably means that small caps overvaluation is sensed much faster than overvaluation of the rest of the market. Hence, it makes sense to short the small caps on times of a general market push, because they will fall faster. (Without these deep IWM pullbacks, IWM would have gained 18% in 2017)

On the other hand, if the general market pulls back, I have the feeling that there will be a negative contagion effect on the small caps too.

In other words, the best way to trade this eight stocks bubble is not to buy them, but it is to short the small caps in August. Shorting the QQQ is dangerous because boosts of momentum can quickly overwhelm short positions, especially since many big stocks still have to issue their Q2 earnings.